A7 Q11-20

Note: Questions 11 - 20 relate to the same "mega" problem. For convenience we have included the entire set of information in every question. For purposes of the questions that follow, assume that changes in working capital are negligible and capex and depreciation are of the same magnitude and therefore cancel each other. This is the assumption we made in most of the videos to focus on valuation effects of borrowing and taxes and to figure out the key differences between alternative valuation methods.

Q11

You are an analyst at Goldman Sachs tasked with valuing a company, Incline, Inc., a private company. You estimate that the earnings of Incline (or EBIT) will be $100,000 next year (at t = 1) and then grow at 2% for the foreseeable future. Specifically, $100,000 at t = 1 and $102,000 at t = 2, etc. Your due diligence and analysis of comparable firms in the same industry have revealed that the beta

asset in the business of Incline, Inc. is 1.50. The risk free rate is 2.50% and the expected market risk premium (the premium that the market is expected to earn over the risk free rate) is 5.00%. The balance sheet of Incline shows that it has $250,000 of debt that it plans to maintain for the foreseeable future and the interest on the debt is 5%. The corporate tax rate is 35%, interest payments on debt are tax deductible and it is reasonable to assume that the riskiness of the

tax shield is the same as the debt. You estimate that the chances that Incline, Inc. will go bankrupt in the future are negligible. Given the above information which method is the most applicable (and easiest) to use to calculate the value of Incline, Inc.?

a) Equity Valuation Method

b) Adjusted Present Value Method

c) Enterprise Value (WACC) Method

d) Multiples Method

Q12

Use the method you chose above to obtain an estimate of the value is??

Q13

The growth rate in the cash flows to equity holders for the foreseeable future will be:

a) Less than 2%

b) Greater than 2%

c) 2%

Q14

What capital structure (debt-to-equity ratio) does the valuation in Q. 12 imply for Incline, Inc. today (t=0)?

Q15

What capital structure (debt-to-equity ratio) will exist at t = 1?

a) A lower D/E ratio than t = 0.

b) Cannot evaluate given the information.

c) A higher D/E ratio than t = 0.

d) The same as t = 0.

Q16

The Enterprise Valuation method cannot be applied to this situation unless:

a) The debt to equity ratio is gxed upfront and never changed.

b) The WACC is adjusted each year for the change in capital structure.

c) The return on asset is adjusted every year for the change in capital structure.

Q17

What will be the value of Incline, Inc. one year from now (at t = 1)??

Q18

What is the return on equity to shareholders of Incline, Inc. from t = 0 to t = 1???

Q19

What is the weighted average cost of capital (WACC) of Incline, Inc. from t = 0 to t = 1 ???

Enter answer here

Q20

What will be the weighted average cost of capital (WACC) of Incline, Inc. one year from from t = 1 to t = 2?

a) 8.90%

b) 9.05%

c) 9.00%

d) 8.95%